Savings Strategies for Kids from a Financial Advisor

It’s no secret—raising kids can be costly. The Brookings Institution estimates that it now costs about $310,605 to raise a child until age 18. This amount does not include the extra cost of college. That's a big investment, but saving early, even in small amounts, can really help over time.

Looking at different savings options can help you plan for various goals. Some accounts even let your child learn about saving and investing as they grow. Here are some accounts to consider when setting aside money for your child’s future.

Savings Account

Parents can open a savings account for their child at a traditional or online bank. The adult can be the main or joint account holder. Depositing money is simple, whether through in-person deposits, online transfers, or automatic contributions from another account. A major benefit is that these accounts are insured by the FDIC for up to $250,000 per depositor.

Although both the parent and child can technically access the funds at any time, it's wise for parents to monitor activity closely and use the account as a way to teach smart saving and spending habits. The ideal savings accounts for kids have no minimum balance, charge no monthly fees, and offer interest rates above the norm.

Certificate of Deposit (CD)

If you can commit to not needing the money for a while, a Certificate of Deposit (CD) could be a good choice. CDs provide a fixed interest rate for a specific term. This can potentially lead to higher returns than regular savings accounts. However, the money is less accessible during this time.

Short-term CDs usually offer better interest rates. However, even the best rates might not keep up with inflation. This could lower your money’s buying power over time. While minors can't open CDs on their own, a parent or guardian can set one up in a custodial account for them.

Custodial Account

Custodial brokerage accounts under the Uniform Transfers to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA) allow adults to invest on behalf of a child. These accounts can be set up at banks or brokerage firms, offering a way to save or provide financial gifts for a child's future. They enable investments in stocks, bonds, mutual funds, and other assets to help secure your child's financial well-being.

However, it's important to consider possible gift and estate tax implications. Custodial accounts are different from other savings plans. They have no income or contribution limits. However, contributions must follow federal gift tax rules.

In 2024, you can give up to $18,000 each year if you file as a single person. If you are married and file jointly, you can give up to $36,000 without paying gift tax. Contributions above this threshold will count toward the lifetime gift-tax exclusion, which is set at $13.61 million for 2024.

Once money is contributed to a custodial account, it’s considered an irrevocable gift. The assets belong to the child.

However, the parent manages the investments until the child turns 18 to 25, depending on the state. At that point, control transfers to the child, who can access the funds for any purpose. Unlike traditional savings accounts or CDs, funds from custodial accounts can only be withdrawn to benefit the child.

Although custodial accounts are taxable, there are advantages. If a child has no earned income, unearned income up to $1,250 is tax-free in 2023.

The next $1,250 is taxed at the child's lower tax rate. Any unearned income above $2,500 is taxed at the parents' rate. For 2024, these thresholds will rise to $1,300 and $2,600, respectively.

Traditional Brokerage Account

If you want more control than custodial accounts offer, you can open a traditional brokerage account in your name. You can designate the funds for your child's future while retaining access to the money while they're still a minor and beyond.

When your child becomes an adult, you can transfer the account to their name. You can do this when you think they are ready. Alternatively, you can name them as a beneficiary if you pass away.

However, the added control comes with tax implications. Any earnings are taxed at your rate, not your child’s, which could mean a higher tax bill. Also, gift tax rules will apply if you transfer assets to your child. It may be smart to spread out the transfer over time.

529 Plan Accounts

A 529 plan is a popular way to save for a child's education. It offers tax benefits that make it a good choice for college and other school costs. Though contributions aren’t deductible on a federal level, many states provide tax benefits for them.

Earnings in a 529 grow tax-deferred, and withdrawals for qualified education expenses are exempt from federal income tax. However, using the funds for non-educational purposes will result in taxes and a 10% penalty on earnings.

If there’s money left over in the account, you have options. It can be given to another eligible family member. Alternatively, the 529 beneficiary can use up to $10,000 to pay student loans.

Starting in 2024, 529 plans can transfer up to $35,000 to a Roth IRA, provided the 529 has been held for at least 15 years. The Roth IRA must be in the name of the 529 beneficiary, and annual contribution limits will apply. Contributions to the 529 plan made within five years before the conversion cannot be rolled over to the Roth IRA.

One of the major benefits of 529 plans is their impact on financial aid calculations. Assets in a student’s name, like savings or custodial accounts, usually count more when deciding financial aid eligibility. They can affect aid by up to 20%.

In contrast, 529 funds are seen as parental assets. They are counted at only 5.64%. This can help increase financial aid eligibility.

Roth IRA for Kids

A Roth IRA can be a smart way to save for a child's future. This is true if the child has earned income in the year they make contributions. This income doesn’t need to come from a traditional job; it can include earnings from babysitting, lawn care, or other small gigs.

Contributions are limited to earned income. However, parents can match their child's contributions. This helps increase their retirement savings.

There are several reasons why a Roth IRA can be beneficial for kids:

●      Children have a long time horizon, allowing them to maximize the power of compound growth.

●      Kids typically make less money, so they often owe little or no taxes. This allows them to contribute to a Roth IRA without tax concerns. This allows them to create a tax-free growth opportunity. This lets money grow over time without taxes later.

●      Although Roth IRAs are meant for retirement savings and usually come with penalties for early withdrawals, there are exceptions. You can make qualified withdrawals without a penalty for certain reasons. These include education expenses, up to $10,000 for a first home purchase, or up to $5,000 for a child's birth or adoption. To avoid penalties, the account must be at least five years old before earnings are withdrawn, and taxes may still apply to the earnings.

●      You can withdraw contributions (not earnings) from a Roth IRA anytime without penalties. This gives you flexibility to access your funds if needed. The tax benefits and flexibility of a Roth IRA make it a great savings choice. It helps with big life events like college, buying a home, or starting a family.

Trusts

Though often associated with wealth, trusts can be a practical and accessible way to save for your child's future. A trust is a legal arrangement where a third party manages assets for the benefit of a designated beneficiary, with specific conditions guiding how and when the assets can be used.

Trusts have two main types: revocable and irrevocable. A revocable trust is a popular estate planning tool. It lets the creator, or grantor, change, modify, or cancel the trust any time before their death.

In contrast, an irrevocable trust cannot be altered once it's established. Parents can create an irrevocable trust while they are alive. They can name their children as beneficiaries.

They can also set flexible rules for how the funds are used. This can include covering health, education, maintenance, or general support.

A revocable trust, which turns into irrevocable upon the grantor's death, can also include similar provisions. Depending on the trust’s terms, there may be estate tax advantages, and assets held in the trust could be shielded from creditors.

Specific types of trusts can be tailored to particular needs. An education trust can state that funds must be used for education costs when a child turns 18.

This gives more options for investments than 529 plans. However, it loses the tax-free growth benefits of 529 accounts for education. A special needs trust allows parents to allocate funds for a child's future care, setting clear guidelines for when and how money can be used.

However, creating a trust is a serious decision that requires careful consideration. Setting up a trust can cost between $1,000 and several thousand dollars. The price is determined by the complexity of the assets and the trust structure.

Bottom Line

Saving money for the children in your life is a great way to prepare them for the future, no matter what path they choose. Creating a financial cushion is just one part of the equation. It is also important to help them develop smart money habits now. Teaching children about budgeting, saving, and investing can go a long way in setting them up for financial success.

Sources:

https://www.fidelity.com/learning-center/smart-money/how-to-save-money-for-kids

Disclosures:

This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.

This material is provided as a courtesy and for educational purposes only.

These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information

529 Plan, or "qualified tuition plan," is an investment account that provides tax benefits when the savings are used for qualified education expenses. Withdrawals from a 529 plan account can be taken at any time, for any reason. But, if the money is not used for qualified education expenses, you will incur a 10% penalty and owe taxes on any investment gains.